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City of Washington v. Daviess County Rural Water System, Inc.

Court of Appeals of Indiana

December 20, 2017

City of Washington, Indiana, Appellant-Defendant/Respond ent,
v.
Daviess County Rural Water System, Inc., Appellee-Plaintiff/Petitioner.

         Appeal from the Daviess Circuit Court The Honorable Gregory A. Smith, Judge Trial Court Cause Nos. 14C01-1608-PL-380 14D01-1608-MI-69.

          ATTORNEYS FOR APPELLANT Paul D. Vink J. Christopher Janak Bose McKinney & Evans LLP Indianapolis, Indiana

          ATTORNEYS FOR APPELLEE Peter J. Rusthoven Nicholas K. Kile Hillary J. Close Barnes & Thornburg LLP Indianapolis, Indiana

          Bradford, Judge.

          Case Summary

         [¶1] In 1992, Appellant-Defendant/Respondent the City of Washington, Indiana, entered into a contract ("the Contract") to sell water to Appellee-Plaintiff/Petitioner the Daviess County Rural Water System, Inc. ("DCRW"). The Contract provides that "[a] ny increase or decrease in rates shall be based on a demonstrable increase or decrease in the costs of performance hereunder[.] " In 2016, the City passed an ordinance which raised DCRW's rates 57%.

         [¶2] DCRW challenged the rate increase in two lawsuits-one a statutory challenge to rate increases and the other a declaratory judgment action-both lawsuits being based on the contention that the City breached the Contract by raising DCRW's rate without a demonstrable increase in the costs of performance. Following a bench trial, the trial court entered judgment in favor of DCRW and invalidated the entire Ordinance on the basis that its provisions were not severable. The City appeals, contending that the trial court erred in (1) concluding that the City breached the Contract, (2) invalidating the entire Ordinance, and (3) denying its motion to dismiss DCRW's declaratory judgment action. Because we disagree with the City's first and third contentions but agree with the second, we affirm in part and reverse in part.

         Facts and Procedural History

         [¶3] DCRW is a nonprofit water utility that purchases water from the City for resale to business and residential customers in rural Daviess County. DCRW has approximately 2800 customers and operates 300 miles of lines, three water towers, and three standpipes. On May 11, 1992, the parities executed the Contract, which obligates the City to sell DCRW up to thirty million gallons of water a month. The Contract, inter alia, set the initial rate schedule for water purchases and provided for authorized annual rate adjustments, subject to the following provision in Section C.5.: "Any increase or decrease in rates shall be based on a demonstrable increase or decrease in the costs of performance hereunder, but such costs shall not include increased capitalization of the seller's system." Appellant's App. Vol. II p. 40.

         [¶4] Before 2016, the City increased DCRW's rates pursuant to the Contract as part of across-the-board, pro rata rate increases on its customers, at least one of which increases was approved by the Indiana Utility Regulatory Commission and none of which were based on a cost-of-service study. The most recent rate increases prior to 2016 occurred in 2010 and 2012, and the latter increase was based on a report by H.J. Umbaugh & Associates ("Umbaugh") which did not include a cost-of-service study. The 2012 increase was computed based on the City's capital extension and replacement budget. The 2010 and 2012 increases raised rates approximately 42% between them. In 2014, Umbaugh prepared a draft cost-of-service study, which, as in 2012, computed rate increases based on the City's capital improvements budget.

         [¶5] In July of 2016, Umbaugh completed a cost-of-service study ("the COS Study") and recommended an increase in DCRW's rates, which were $1.43 per 100 cubic feet at the time. Unlike the 2012 and 2014 reports, which used a "detailed extension and replacement" or "capital improvement program" accounting method, the COS Study based its proposed rate increase on using the City's "depreciation expense" to compute the City's revenue requirements and cost of providing service to DCRW. Appellant's App. Vol. II p. 15. The switch to using the depreciation method resulted in an annual increase in the City's revenue requirement of more than $400, 000.00.

         [¶6] On August 8, 2016, the City Common Council passed, and the City's mayor approved, Ordinance 12-2016 ("the Ordinance"), which increased the wholesale rate for sale-for-resale customers to $2.25 per 100 cubic feet, which had the effect of increasing DCRW's rates approximately 57%. The Ordinance also increased the rates of individual customers who lived outside the City by 14.8%. The increase implemented by the Ordinance would increase the cost of water purchased by the DCRW by approximately $325, 000.00 annually.

         [¶7] On August 12, 2016, pursuant to Indiana Code section 8-1.5-3-8.2, [1] DCRW filed a petition in Daviess Superior Court challenging the Ordinance as it applied to them, alleging that it violated Section C.5. of the Contract. Also on August 12, 2016, DCRW filed a declaratory judgment action in Daviess Circuit Court, seeking to have the Ordinance declared void as applied to DCRW. On August 22, DCRW moved in Daviess Circuit Court to consolidate the two cases, which motion the trial court granted on August 26, 2016.

         [¶8] On October 26, 2016, the trial court conducted a one-day bench trial Accountant Steven Brock testified that he had prepared an "Exception Report" to the COS Study for DCRW and that, in his opinion, the COS Study did not propose rate increases for DCRW that were based on a demonstrable increase in the cost of performance. Brock testified that, using the same methodology as was used in 2012, the City's net revenue requirements increased approximately $263, 339 from when rates were set in 2012 to 2016, or approximately 5.43%. Kerry Heid also opined that the COS Study did not support a 57% water rate increase for DCRW.

         [¶9] On January 24, 2017, the trial court entered its judgment, concluding, inter alia, that the City was bound by the Contract; the Ordinance's rate increase as to DCRW breached the Contract; and the provisions of the Contract regarding the DCRW rate increase could not be severed from the provisions raising the rates on non-City-residents, thereby invalidating the entire Ordinance. The trial court's order provides, in part, as follows:

         FINDINGS OF FACT

....
23. At the hearing in this cause both [City] Mayor Wellman and Washington witness David Dahl testified that all prior increases had been across-the-board (pro-rata as to all consumers) and improvements made to Washington's system since 1992 had been recovered through those rate increases.
….
47. At the hearing in this cause, DCRW Witness Mr. Kerry Heid raised several serious concerns about the 2016 Umbaugh study and Mr. Dean Rogers, on behalf of the City of Washington, responded to these criticisms.
48. Accordingly, the Court finds that the question of how much it currently costs Washington to serve DCRW is in dispute.
….
51. The July, 2016 Umbaugh report calculates the City of Washington's revenue requirement utilizing depreciation expense.
52. The evidence revealed that the 2012 and 2014 reports utilized a detailed extension and replacement budget instead of the depreciation expense figure.
53. Depreciation changed very little among 2012, 2014 and 2016. (See Pl.'s Ex. 59; see also Pl.'s Exhs.3, 14, 17 and 18.)
54. However, by switching from the budgeted improvements method to depreciation resulted in an increase to Washington's revenue requirement by more than $400, 000 per year. (See Pl.'s Ex. 59).
55. The Court finds that this is not an actual increase in costs, but an increased assignment of capital costs that the City of Washington was already incurring and had already shared proportionately with all consumers (including DCRW) through the last rate increase in 2012.
56. The Court makes this finding concerning the change in methodology based on some of the following facts and evidence. On cross-examination the City of Washington witness, Mr. Dean Rogers, confirmed that: (1) Washington's revenue requirements have only increased by about 15.7% since 2012 according to Umbaugh's calculation; (2) when total costs being incurred by Washington in 2012 (as reflected in the 2012 Umbaugh report) were adjusted to measure them the same way as in the July, 2016 Umbaugh report (i.e., using depreciation expense in the revenue requirement calculation as opposed to an extension and replacements budget), costs have only increased by approximately 5.89%; and (3) Mr. Rogers did not know the difference between what he contends is the current cost to serve DCRW and what that cost was in 2012 when DCRW incurred its last rate increase. (See Pl.'s Ex. 59.)
57. Additionally, Mr. Seever, who was a Witness for the City of Washington, testified that he would not expect DCRW'S relative share of the costs to have changed since 2012. (See Pl.'s Ex. 55, p. 31, lines 8-12.)
58. The 2016 Umbaugh report shows (at page 15) the derivation of the revenue requirement Washington allocated to DCRW, which directs the portion of debt service and depreciation based on the allocation of capital plant derived on page 10. It also shows the operating expenses and taxes apportioned on the basis of allocated capital plant at pages 12 and 13. P1.'s Ex. 3, pp. 10, 12, 13 & 15.
59. The Court finds that the City of Washington has not demonstrated that its proposed rate increase to DCRW is based upon a "demonstrable increase in costs" as required in the contract since the contract was last modified by changing rates in 2012.
....
67. All rates in a rate ordinance are interrelated such that if the Court were to find one rate is unlawful, it would impact other rates in the ordinance.
68. The rate ordinance at issue herein (Ordinance No. 12-2016) does not contain a ...

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